The Corporation as a Means to Allocate Risk

Question 1

What are the (2) purposes of limited liability for shareholders?

Answer 1

1. Incentivizes investing

2. Fairness by separating ownership from management

Question 2

What are the (2) risks of limited liability for creditors?

Answer 2

1. Creditors can only look to the entity as a whole to get paid
2. If there’s not enough money in the venture, there isn’t enough money to pay creditors back

Question 3

What are the (3) ways creditors can protect themselves?

Answer 3

1. Due diligence (i.e., investigate the company and amount of capital)
2. Ask for personal guarantee from shareholders (only available for voluntary creditors, not tort victims)
3. Charge higher interest rates for higher risk

Question 4

What are the (3) ways state law protects creditors?

Answer 4

1. Imposing minimum initial capitalization requirements to create a cushion for creditors that can’t be removed/distributed – NOT ANYMORE
2. Limitations on cash distributions to shareholders
3. Piercing the corporate veil

Question 5

What are dividends?

Answer 5

Cash payments made to all shareholders based on the amount of share ownership

NOTE: Companies do not have to pay dividends – DGCL § 170

Question 6

What are the (2) approaches to dividends?

Answer 6

1. Capital Impairment Approach (Delaware)

2. MBCA Insolvency Approach

Question 7

What is the Capital Impairment Approach?

Answer 7

1. Corporation can only make distributions to shareholders out of surplus, and not out of capital
2. Surplus = Net assets - Capital

Question 8

How do you calculate capital?

Answer 8

Capital = Par Value x Number of shares outstanding

Question 9

What is par value?

Answer 9

1. Originally = cost of shares x number of shares

2. Today, it’s made up and companies monkey around with it

Question 10

What are the (2) means of achieving surplus?

Answer 10

1. Reduction surplus – decrease par value

2. Revaluation surplus – revalue assets to reflect appreciation

Question 11

What is the Insolvency Approach?

Answer 11

Can’t make a distribution if, after giving it effect:

1. Corporation wouldn’t be able to pay debts as they come due (equitable insolvency) – current assets > liabilities AFTER distribution
2. Corporation’s total assets would be less than total liabilities (bankruptcy insolvency) – total assets > liabilities AFTER distribution

Question 12

What is the Alter Ego Test for piercing the corporate veil?

Answer 12

1. Shareholder must completely CONTROL and dominate the corporation;
2. Shareholder’s control must have been used to commit an INJUSTICE
3. Plaintiff must have suffered harm as a result (CAUSATION)

Question 13

What are the (4) factors the court examined for the Alter Ego Test in Consumer Co-Op v. Olsen?

Answer 13

1. Lack of corporate formalities (i.e., board meetings, elections, issuing stock, minutes)
2. Commingling of corporate and personal assets
3. Siphoning of funds
4. Undercapitalization

Question 14

How do you pierce the corporate veil to reach incorporated shareholders?

Answer 14

Same analysis of Control-Injustice-Causation but harder to reach unincorporated shareholders.

Question 15

How is control more difficult to prove when piercing the veil against incorporated shareholders?

Answer 15

1. Wholly-owned subsidiary is not sufficient control per se
2. Must have day-to-day participatory control for a court to think about piercing subsidiary’s veil to reach incorporated parent?
3. Courts won’t find substantial domination if the books, records, accounts, offices, staff, etc. are separate

Question 16

How is injustice more difficult to prove when piercing against incorporated shareholders?

Answer 16

Using the limited liability shield of corporate law to protect assets from creditors does not = sufficient injustice

Question 17

What is a parent-subsidiary relationship?

Answer 17

Relationship where one corporation owns a controlling amount of stock in another corporation?

Question 18

What are (2) ways to create a parent-subsidiary relationship?

Answer 18

1. Corporation A buys outstanding stock of corporation B: A owns 100% of the stock but A’s shareholders are not shareholders of B;
2. Corporation A creates newly formed subsidiary, files certificate of incorporation and parent owns all stock